JULY 18, 2016 VOLUME 23 NUMBER 27
One of the great things about our area of law practice is that the community of practitioners is just that — a community. Take, for instance, our good friend Amos Goodall from State College, Pennsylvania: he’s one of the leading elder law attorneys in the country. Amos is not just nationally-known, either — he’s also an excellent communicator. This week he tackles a topic of considerable interest to our clients: estate planning for people who have Individual Retirement Accounts or other retirement savings. Here is his plain-language explanation:

Many folk have large retirement accounts. According to the Investment Company Institute 2016 Yearbook, in 2015, members of 60% of US households had invested $24 trillion in retirement market assets, including IRA’s, 401k’s, 403b’s, Simple IRAs, and others. This article discusses IRA’s, and someone with any of the other types of accounts should consult with knowledgeable legal and financial advisors. In fact, every single general rule stated in this article is subject to exceptions, and there may also be specific situations where these rules should be purposefully ignored. This article should be considered simply a guide for asking questions of your advisor (and better understanding the answers), rather than a roadmap for do-it-yourself action.

The typical estate plan for a married couple with IRAs is naming the surviving spouse as the first (or primary) successor owner. There are special tax benefits for a surviving spouse that do not apply to any other possible successor owners. There are other options, but these should not be pursued without specialized advice.

Classically, they name their children as the contingent or remainder successor owners who will receive the accounts upon the second of their parents’ deaths. Single IRA owners may name their children as primary successor owners, and those without children typically name other family members to receive these accounts. Again, there are other options (including some charitable ones) that should be considered after appropriate advice.

Most IRA owners want to keep IRA assets invested as long as possible. Since growth is not taxed until the funds are withdrawn, they will grow faster. Thus, the longer they are invested, the greater they will be. This is called “stretching” the IRA.

One of the benefits to naming a surviving spouse as the first successor owner is that the spouse is permitted to “roll” the IRA into his or her own name as one of the available options. No one else has this option, and everyone else must begin withdrawing funds (and paying taxes) as soon as the IRA becomes theirs, called the “minimum required distribution” (or MRD). For younger successors, the MRD is not great; an eight year old successor owner will need to withdraw a little over 1% (roughly one-seventy-fifth) as his or her MRD in the first year after the original owner’s death. In contrast, a sixty-five year old successor would have an MRD of almost 5%, and the MRD for a seventy-one year old spouse would be just over 6%.

Thus, it makes sense to name as young a beneficiary as possible so as to lengthen the process and thereby to maximize the effect of compounded tax-deferred growth. For example, if a seventy year old widow leaves an IRA with $100,000 to an eight year old great-grandchild (assuming there are no generation-skipping tax considerations), and the IRA grows at 3%, then at age 65, the great-grandchild will have withdrawn over $207,000 from the account and it will still be worth over $130,000–quite a positive result for a $100,000 IRA. (At a higher rate of growth, say 6%, that same $100,000 IRA would be worth $700,000 at age 65, and MRD withdrawals would be as high as $40,000/year).

Most IRAs don’t last this long, and it would not surprise anyone that when our eight year old turns eighteen, he or she will find a reason to withdraw much of this inherited wealth. One way to be certain that MRD withdrawals are made and to limit extra withdrawals to actual needs, is naming a trust as successor owner. IRS regulations do not allow many traditional trusts to stretch. However, if the trustee is required to withdraw and pay out at least the MRD each year, the IRS will allow the trustee to use the great grandchild’s life expectancy. This is called a “conduit” trust. Another IRA trust is called an “accumulation” trust, but this are fairly complicated to set up. Describing any IRA trust as “simple” might be stating an oxymoron, but compared to an accumulation trust, a conduit trust is straightforward for knowledgeable counsel.

The trustee of a conduit trust may make larger withdrawals if necessary (like helping with medical expenses or college) but the beneficiary will need to convince the trustee that other withdrawals are truly necessary. The trustee might say “I agree you need a new car, but look for a good used Chevrolet rather than the new Tesla you want”. Several institutions offer “Trusteed IRA” plans for a fee, and this has the added benefit of having professionals invest the IRA funds (which may result closer to 6% than 3% growth, as in the example above); it also provides continuity in trust management. Other investors opt for family members as trustees, which may save money in fees but might impose a burden on family members.

With good planning, it is possible to provide a great gift to descendants; a trust makes it more likely they will receive it.